Image source: Data vector created by stories - www.freepik.com
India has crossed 2 Lakh mark and became the world's fourth fastest-growing Covid-19 outbreak, Cyclone Nisarga is reaching out to Maharashtra for mass destruction, Cyclone Amfan has already done its job, Swarms of millions of locusts already devastated the crops in India, Sizable number of Chinese troops moved into eastern Ladakh to escalate the India-China tensions , Asteroid 'taller than Empire State Building' rocketing towards Earth at 11,200 mph and Delhi NCR experienced 5 earthquakes within 45 days but, NIFTY has rallied whopping 33% its March 23 bear market lows. 10 years of data shows June belongs to BULLS.
As per many experts, It can be a lifetime opportunity to buy some fundamentally strong stocks with clean balance sheets at a cheaper rate as NIFTY is now at almost 2017 levels, small and mid caps stocks are trading at 2011 and 2014 levels respectively.
Let's learn 'How to any Analyse a stock in less than 10 minutes' so that you can select best stocks for your investments.
There are 10 useful tools that can be used to analyse 'any' stock. I will take the examples of the 'Wires and Cables' Industry and compare among its three major players. Polycab, Finloex Cables and KEI Industries. Let's start:
1) Price to Earnings Ratio (P/E Ratio)
Formula: Current Market Price / Earnings Per Share
This is the most common ratio which you must check to find out the 'valuation of the stock' i.e. how the market is valuing the stock and how stock is valued as compared to its peers.
Simply put, If the P/E Ratio of stock 'A' is 5, it means that you are giving 5 Rs to the company, for every 1 Rs. the company earns.
Of course, You must be willing to give less to the company, for the company to earn 1 Rs. For value investors, PE ratio must be lessor than the Industry PE
Note: High PE stocks are called as 'Growth Stocks', Low PE stocks are called 'Value Stocks'.
Example: Let's compare the P/E ratios of all three companies.
As per numbers, you are paying 9 Rs. to the company, for the company to earn 1 Rs. So, based on P/E ratio, Finolex cables is trading cheap as compared to its peers.
2) Price to book value per share.
Formula: Current Market Price / Book Value per share
What is Book Value: Some investors refers to book value as Equity or Net worth. Book value can be calculated as Total asset - Liabilities.
Book value per share: ( Total asset - Liabilities)/Total outstanding stocks
So, there is a huge difference between the stock's 'market price' and 'book value per share'. Because book value is the actual value of the stock in company's balance sheet and stock price is a price decided by investors and traders in secondary market.
For value investors in idle case, Price to book value must be less than 1 but majorly almost every stock trades at a premium or more than the book value.
In this case Finolex cables is trading cheaper than its peers.
3) Net Profit Margin (%):
Formula: Net Profit / Total Revenue
If company A has generated the revenue of 100 Rs with net profit of 10 Rs and company B has generated revenue of 110 Rs with a net profit of 10 Rs. then which company is better? Of course A, because company generates same profit with lessor revenue.
Net Profit Margin of A: 10/100 = 10%
Net Profit Margin of Company B: 10/110 = 9.09%
So Net Profit Margin of the company must be as high as possible.
If you don't want to read the entire P/L statement of the company then you can talk about only NPM.
In our example, Finolex cables NPM is way better than other two peers.
Remember: NPM must be as high as possible.
4) Debt to Equity Ratio
Formula: Total Debt / Total Equity
This ratio is important especially during this pandemic where are companies are defaulting on debt payment. Lesser the debt, better the company.
So, Debt to Equity Ratio must be close to zero or as per Warren Buffett it must be less than .5.
Let's take the example which we had used in point 2
The above company is debt ridden where debt is exceeding the equity significantly.
In our example, Polycab and Finolex Cables are debt free as compared to KEI.
5) Return on Equity (ROE)
Formula: Net Profit / Book Value or EPS/ Book value per share
ROE talks about the profitability of a business in relation to the shareholder's equity i.e. how much the company earned against share holder's fund.
Higher ROE gives confidence to investors and it must be as high as possible.
In our example: KEI Industry has higher ROE.
6) Interest Coverage Ratio
You are running a company and paying 100 Rs per year as interest payment against the loan you have taken from the bank. Think about the case when your operating income is only 70 Rs. this year due to any reason. How would you pay rest 30 Rs. (100 - 70 Rs) Rs to the bank? This is where you need Interest Coverage Ratio to compare company's operation profit (EBIT) to the interest expenses.
Formula : EBIT (Operating profit) / Interest Expenses
If the ratio is 10 then it means company has 10 times potential to pay its interest expenses. That is why Interest Coverage Ratio must be as high as possible.
In our example, Finolex Cables has whopping 466 times potential to pay its interest expenses. 466, My god really?
7) Inventory Turnover Ratio
Inventory turnover is a ratio simply shows how many times a company has sold and replaced inventory during a given period. Better the sales, higher the inventory turnover ratio would be. No company wants to hold its inventory in house, of course they have made the final product to sell, not to keep it safe in the company.
Higher ratios define, how quickly they are replacing/selling inventories during the entire year. So, Inventory Turnover Ratio must be as high as possible.
KEI is winning the game this time.
8) Quick Ratio (Acid Test Ratio)
Current Assets defines as cash and other assets that are expected to be converted to cash within a year. Current Liabilities defines as amounts due to be paid to creditors within twelve months. The ratio of Current Asset and Current Ratio is called as Current Ratio.
But companies are very wise, as inventory is also included in the Current Assets so even if the inventory went unsold at the end the year, Current ratio goes unaffected. So, introducing Quick Ratio
Formula : (Current Asset - Inventory) / Current Liabilities
That's fair now. Quick Ratio must be in a range of 2-5 because higher quick ratios also indicate that some of the funds are sitting idle.
In our example, Finolex Cables wins the race.
9) Free Cash Flow
If you have 100 Rs in your pocket we can say you have to pay 20 Rs to Mr.A, 30 Rs to Mr. B and 25 Rs to Mr.C then we can say your 'Free Cash' is 100-20-30-25 = 25 Rs.
Same applies to companies, Free cash flow is cash available for shareholders. They can reinvest in company or they can distribute it as dividend or whatever. Free cash flow of the company must not negative.
In this case we can't compare free cash flow of Polycab, Finolex and KEI because free cash flow numbers will be depending on the size of the company.
All three companies have fine numbers.
10) Pledge Shares (गिरवी)
When a company is willing to raise funds, it can be done via Debt or Equity. But if both ways don't work (or maybe promoters aren't willing to go for either way) then they pledge their holdings to the financial institutions and raise funds.
This is the riskiest way to raise funds because if the share price goes down and promoters didn't increase the pledge shares then financial institutions revoke the pledge and take acquire the company (upto pledged %). This happened many times.
So, Pledge % must be zero.
All three companies have zero pledge shares.
Let's summarize it, now:
No doubt I will go for Finolex Cables as it is meeting 8 out to 10 requirements.
That's how you can take any industry, take out its top 3 or 4 players, make this excel and pick the best one.
Note: For any Banking/NBFC stock you must choose these 10 tools for analyzing.
Hope it was useful. Happy Investing!
For more articles, Join Free Market notes telegram channel here
For Hindi viewers, here is the detailed explanation:
Research Analyst (SEBI Regd.)
Linkedin | firstname.lastname@example.org